The risks of investing in Chinese value traps

Dean Fergie

Cyan Investment Management

A red card for XPD Soccer highlights the risks of investing in Chinese 'value traps'. As a vertically integrated manufacturer, distributor and retailer of soccer boots in China, XPD Soccer (ASX:XPD)  had all the hallmarks of an exciting business. Leveraging the growth in China, multiplied by the growth in the sport, combined with a low PE and a high cash balance, might have given investors every confidence this was a solid investment proposition. 

Indeed in March 2016, the company was promoting strong CY2015 underlying earnings of $16m (7cps); cash at bank of $37m (10cps); and a 1c dividend, which could be all yours for just 15cps (equivalent to a market cap of $58m).  Too easy.

Fast forward 12 months and a few things have changed, and not for the better. The company raised $7.4m in a placement (which was curious given half the market capitalisation was in 'cash and bank deposits').  More confoundingly, not 4 months later, a share buy-back was announced, yet never activated. Profitability fell in CY16 to $13.4m, cash was up to $43m, yet the share buy-back was cancelled and the dividend suspended.  Investors hoping to share in some the balance sheet value and the profitability have been sorely disappointed.  The shares are presently trading below 4c, down over 80% on their IPO price which equates to less than half of their 10cps cash backing. It's still cheap. Go figure.

XPD isn't the only example.  

Take Wonhe Technology (ASX:WMC) which listed in December 2015 raising $3.4m from ASX investors and championing a market capitalization a little over $30m with cash on the balance sheet of $55m.  That is not a typo.  Spend $30, get $55.  Too good to be true. How many can we have?  

Despite WMC reporting a CY16 profit of $16m, cash has fallen to $37m thanks largely to their $21m "repayment of loan from USA parent entity to fund in Bejing project" (sic).  At 17c, WMC is presently trading 15% below its IPO price which still equates to less than the 24cps cash backing at the end of 2016.

China Dairy (ASX:CDC) raised $17m in April 2016 (equating to a market cap of $147m) through an initial prospectus that highlighted FY15 profitability of almost $40m and a pro-forma cash balance over $80m. Dairy. China. Count us in.
Despite CDC declaring dividends totalling 1.2cps and reporting increased profitability of $18m in the six months to 31 December 2016, the shares are trading 35% below on their IPO price. This has no doubt been influenced by the reported cash having shrunk to $29m at the end of 2016. 

Enice (ASX:ENC) a ‘vertically integrated wireless telecommunications technology enterprise’ raised $25m in October 2015 forecasting profitability of over $8.7m for CY2015.  Mobile technology based in China.  Exciting stuff.  Despite reporting a $8m profit in CY16, ‘cash and cash equivalents’ have fallen from $29m to around $4m.  Again, investors have taken a cane to the stock, halving the value of the shares since IPO.

Beware the value traps. 

Sometimes if it's too good to be true, it's too good to be true.

2 stocks mentioned

Dean Fergie
Director & Portfolio Manager
Cyan Investment Management

Dean has over 25 years experience in the funds management industry covering all major asset classes. He holds as Master of Applied Finance and is a Graduate of the Australian Institute of Company Directors.

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